Morningstar's wish

Founder Mansueto discusses firm's integrity, growth

SAN FRANCISCO (MarketWatch) -- Morningstar Inc., the investment-research firm, faces several hurdles as a newly public company, not least of which are regulatory probes into possible conflicts in its retirement-plan consulting unit.

The subpoenas by the Securities and Exchange Commission, the U.S. Labor Department and the New York Attorney General's office are ironic, given Morningstar's outspoken advocacy of mutual-fund industry reform and its stinging rebuke of fund companies and executives implicated in the improper-trading scandal.

Chairman and Chief Executive Joe Mansueto says objectivity and independence is a cornerstone of Morningstar's
MORN, -0.26%
culture -- and central to its future. A strong foundation also will be crucial as the Chicago-based firm seeks to build its product lineup, customer base and geographical reach

Morningstar's evolution is ultimately Mansueto's design; he founded the company in his Chicago apartment in 1984 and controls more than 75% of the shares outstanding. In an interview with MarketWatch at the recent Morningstar Investment Conference, Mansueto defended the firm's integrity and detailed its expansion plans.

Is it a conflict for Morningstar to have business relationships with companies that it's also judging?

The independence and integrity of the firm are sacrosanct. That's our biggest asset, our name and reputation, so we'd never do anything that would jeopardize that. Our ratings are quantitative. When we rate mutual funds, there's a methodology that's transparent, up on our Web site. There's nothing anyone can do at Morningstar to say I like this manager more, I'm going to give him an extra star.

We've set ourselves up like the major media companies. We're separating the business side from the editorial, or in our case the analyst side. So we have all of the requisite walls in place, ethics policies, to keep a very firm delineation between these two groups. The sales side cannot talk to our analyst group directly. It has to go up through the chain of command. The analysts can remain editorially independent but sales can still conduct business with the firms we cover.

We are not by any means alone in this regard. Moreover we've got a purer business model. where some of our competitors charge the entity they're rating, we don't charge anyone to be rated. So our analysts can be candid in how they evaluate a fund or a stock. We make our money through licensing. We create the research first, and then we license it in our products. It gives our analysts a great degree of freedom in being very candid.

How does Morningstar's investment-advisory unit interact with the analysts who provide public fund and stock research?

We do have a [registered investment adviser] that does provide investment advice to people in 401(k) plans. We have another service that manages portfolios of mutual funds that we distribute through advisers. These are separate, distinct groups. They have different analysts than those who are on the public Morningstar.com Web site.

Second, we're managing assets and providing advice with mutual funds. There's no incentive for any of our analysts to talk up a fund, because they're not going to change the price of the fund. A fund is very different from a stock. So we can give advice on funds, and there's nothing anyone can do on the retail side that can affect that.

In hindsight, has the advice business been the right move for Morningstar?

Absolutely. It very much fits within the mission of the firm. Can we do things to help investors? If you look at providing advice, there's just a huge need for that. Our services are available to 11 million 401(k) plan participants. We're the largest in terms of reach in the country. And there's a huge need for investors who have had the responsibility thrust on them to manage their retirement savings.

We're in a good position to help people plan and invest for their retirement. If we have expertise and capabilities in understanding mutual funds and putting together portfolios of mutual funds, it seems this is a very legitimate way to fulfill our mission.

How will Morningstar broaden its product lineup and market reach?

We want to stay focused on helping investors. We don't want to diversify from that and get involved with things that are tangentially related, like banking, mortgage, insurance.

That said, there's lots of things we can do. We've added separate accounts and hedge funds. We put the hedge fund database together over the last year. We want to add analysis to that to not only provide investors with data and analytics but also offer written evaluation and commentary. That's how we've made our mark in other areas, so we certainly want to do that with hedge funds and separate accounts.

We don't do anything with fixed-income data. I'd love to add a fixed-income database. We don't do anything on the credit side of the ledger, so more risk analysis, credit analysis, something on the debt side is of interest.

The trend is toward no guidance and equal access. If we start giving guidance, there might be some tendency for people to alter their behavior internally, maybe do things that might not be in the best interests of the company. We didn't really want to create any kind of incentive for that to happen. If you hold out a number, people might -- who knows what they might do to meet that number? That's kind of a classic trap that companies fall into.

Moreover, by its nature, providing earnings forecasts or guidance, that by itself affects your stock price. That makes me a little uncomfortable, that by giving an estimate you're going to affect the price. I'd rather the results speak for themselves. So issue your earnings, the stock reacts and adjusts accordingly.

Our intent is to keep both potential shareholders and current shareholders fully informed about our business. We're happy to answer questions. We just want to make those answers available to everybody at the same time. So we're asking people to submit questions in writing; every month we'll release the answers to those questions. We'll put together a detailed annual report, have a company annual meeting -- everything an investor needs to understand what's going on in the company.

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